Specific Transactions & Events Flashcards
What is the date of application used by firms for accounting changes?
First day of the year of change.
What accounting approach is used for a change in reporting entity?
Retrospective method.
List the two accounting approaches for recording accounting changes.
- Retrospective; 2. Prospective.
What accounting approach is applied to principle changes?
Retrospective.
What concept is displayed when there is restatement of prior year financial statements?
Comparability
What accounting approach is applied to error corrections?
Retrospective (Restatement).
List the three types of accounting changes.
- Change in accounting principle; 2. Change in accounting estimate; 3. Change in reporting entity.
What accounting approach is applied to estimate changes?
Prospective.
What is a change in accounting principle?
A change from one generally accepted accounting principle to another when there are at least two acceptable principles or when the current principle used is no longer generally accepted.
What type of changes and events are comparative financial statements of prior periods changed for?
Accounting principle changes and error corrections.
How is a change in method that is indistinguishable from a change in estimate accounted for?
Change in estimate.
What account records the effect of principle change on prior years?
Retained earnings.
What accounting change is often impracticable to compute a cumulative effect?
Change to Last In First Out (LIFO).
What account is debited when an accounting principle change causes income in prior years to decrease?
Retained earnings (cumulative effect of change).
What is the amount of the cumulative effect reported in the earliest reported year of the retained earnings statement?
The effect of the change on years before the earliest year reported.
What is the pretax amount of the cumulative effect of a change in inventory method?
The difference in inventory balance for the new and old methods, at the beginning of the year of change.
What is the amount recorded for the change in deferred taxes for a change in accounting principle?
The pretax cumulative effect multiplied by the tax rate.
What is the first computation in accounting for an estimate change involving a depletable resource?
Compute book value at the beginning of the year of change.
What is the most frequent type of accounting change?
Estimate change.
How is a change in depletion method accounted for?
Prospective approach (same as estimate change).
What accounting approach is applied to changes in depreciation method?
Prospective.
What is the amount of cumulative effect recorded for change in depreciation method?
None (prospective approach is applied).
What disclosures are required for estimate changes?
Effect of the change on income from continuing operations and net income for the year of change.
What is the rationale for applying the prospective method to estimate changes?
The new information triggering the change is not applicable to prior years.
What financial statement errors will remain if an error counterbalances?
All account balances affected by the error are still erroneous, except for retained earnings.
How many years should be considered when computing the adjustment to the earliest year in the retained earnings statement?
All years before the earliest year in the statement affected by the error.
Define “prior period adjustment.”
Change in retained earnings for error corrections.
What accounting approach is applied to corrections of errors affecting prior year net income?
Accounting approach applied is retrospective.
What is the change in retained earnings for an error correction called?
Prior period adjustment.
Define “counterbalancing error.”
An error whose effect on retained earnings automatically corrects itself after a number of years.
How many years should be considered in the journal entry to correct retained earnings?
All years affected by the error through the beginning of the year of change.
What happens to the net book value of the asset?
Depreciated or depleted.
How is the annual accretion expense and corresponding increase to asset retirement obligation (ARO) found?
Multiplying the interest rate used in capitalizing the initial amount, by the beginning balance in the ARO.
What amount does the asset retirement obligation increase to over time?
The final amount expected to be paid.
List the components of asset retirement obligation (ARO) costs.
Costs to dismantle, reclaim, remove, etc.
When does an environmental liability need to be accrued?
When the liabilities are both probable and reasonably estimable.
How much is capitalized to the asset retirement obligation?
The present value of the estimated future payments (initial fair value).
Define/describe a “legal consolidation”.
A new entity is formed to combine (consolidate) two or more preexisting entities.
Define/describe a “legal merger”.
One entity acquires either a group of assets constituting a business or a controlling interest of another entity and “collapses” the acquired assets/entity into the acquiring company.
Define “parent company” as it relates to business combinations.
Designation of the Investor in a business combination.
List the primary mean of accomplishing a business combination.
The acquisition by one entity of the common stock of another entity to gain control of the investee.
Describe how income is determined at the date of a combination.
Only acquirer’s operating results up to the date of combination enter into determination of “consolidated” net income.
Define/describe a “legal acquisition”.
One entity acquires controlling interest of another entity, but both continue to exist and operate as separate legal entities.
Identify the legal forms of business combination that will not require preparation of consolidated financial statements.
A legal merger or a legal consolidation will not require preparation of consolidated financial statements. Only a legal acquisition will require preparation of consolidated financial statements.
What is the designation of the investee in a business combination?
Subsidiary company.
What may be acquired in a business combination?
A business entity either acquires a group of net assets that constitutes a business or acquires equity interest in an entity.
List the three legal forms of business combinations.
- Merger; 2. Consolidation; and 3. Acquisition.
Describe how income is determined at the end of the year for a combination.
Acquirer’s operating results for the year plus acquiree’s operating results after the combination enter into the determination of consolidated income for the year of combination.
Describe how income is determined for subsequent years of a combination.
Acquirer’s and Acquiree’s operating results enter into determination of consolidated net income.
List the business combinations for which the acquisition method of accounting does not apply.
- Joint ventures; 2. Entities under common control; 3. Between not-for-profit organizations; 4. For-profit entity acquired by a not-for-profit organization; 5. Acquisition of assets that do not constitute a business.
Define “measurement period”.
The period after the acquisition date during which the acquirer may adjust any provisional amounts recorded at the acquisition date. It provides the acquirer reasonable time to obtain information needed to identify and measure accounts and amounts that existed as of the acquisition date. It ends when the acquirer obtains that information or determines that no additional information is available, but in no case should it exceed one year.
List the five elements (or steps) involved in applying the acquisition method of accounting to a business combination.
- Identify the acquirer; 2. Determine the acquisition date and measurement period; 3. Determine the cost of the acquisition; 4. Recognize and measure the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquired entity; 5. Recognize and measure Goodwill or a gain from a bargain purchase.
Define “acquisition date”.
The date on which the acquirer obtains control of another business (i.e., group of assets that constitute a business or a separate legal entity). It usually is also the “closing date” for the combination.
When a business combination is effected through an exchange of equity interest, what are five factors to consider that indicate which entity is the acquirer?
Which combining entity/entities 1. Issued new equity interest; 2. Owners have the larger portion of the voting rights; 3. Owners can select or remove a voting majority of the governing body; 4. Former management dominates that of the combined entity; 5. Paid a premium over the precombination fair value of the equity interest of the other combining entities.
For the purposes of applying the acquisition method to a business combination, what may constitute a “business?”
A business may be: 1. A group of assets or a group of net assets (that constitute a business); 2. A separate legal entity (that is a business).
What is the method that is required to be used in accounting for most business combinations?
Acquisition method.
Under what circumstance is fair value not used to measure assets and liabilities transferred in a business combination?
When the assets and liabilities are transferred to the acquiree but remain under the control of the acquirer because the acquirer obtained control of the acquiree (which holds the transferred asset or liability). In such a case, the asset or liability should be transferred at carrying value, not fair value.
Describe the nature of contingent consideration in a business combination.
Contingent consideration is either: 1. An obligation of the acquirer to transfer additional assets or equity to the former owners of the acquired business if future conditions are met; or 2. A right of the acquirer to a return of previously transferred consideration if future conditions are met. Contingent consideration is recognized at fair value as of the acquisition date as part of the cost of the acquiree.
List the elements that make up the cost of an acquired business.
Fair value of: 1. Assets transferred; 2. Liabilities incurred; 3. Equity interest issued.; 4. Contingent consideration obligations of the acquirer; 5. Required share-based employee awards for precombination services.
How is the exchange of share-based employee awards treated in a business combination?
If the exchange is required: 1. The portion of the value of the replacement awards that relates to precombination services is part of the cost of the acquired business; 2. The portion of the value of the replacement awards that relates to post-combination services is expensed. If the exchange is voluntary, the value of the replacement awards is expensed.
Identify at least three items acquired in a business combination for which the acquirer has to make a decision as to the classification or designation of the item.
- Investments, as to whether held-to-maturity, held-for-trading, or available for sale; 2. Derivative instruments, as to whether used for hedging or speculation; 3. Embedded derivatives, as to whether they will be separated from the host instrument or not; 4. Long-term assets, as to whether they will be used or held for sale.
Describe the requirements of the acquisition when a business combination is carried out in stages (or steps).
Equity interest in the acquiree which is acquired by the acquirer prior to the business combination is remeasured to fair value at the date of the combination (acquisition date). Any difference between the precombination carrying value and the acquisition date fair value is recognized as a gain or loss in income of the period of the combination. The fair value of the precombination investment is included as part of the cost of the investment value (i.e., cost of the investment in the acquiree) to the acquirer.
Identify at least five items acquired in a business combination that would be measured at something other than fair value.
- Income tax items, use ASC 740 and other guidelines; 2. Acquiree’s employee benefit liability/asset, use various related GAAP; 3. Indemnification assets, use the same measurement basis as indemnified item; 4. Reacquisition rights, use unamortized balance; 5. Share-based employee awards, use ASC 718; 6. Long-term assets held for sale, use ASC 360.
Identify the general acquiree-related elements that must be recognized and measured by the acquirer in a business combination.
- Identifiable assets acquired; 2. Liabilities assumed; 3. Noncontrolling interest, if any.
What values are compared to determine if there is Goodwill or a bargain purchase in a business combination?
The fair value of the total investment in the acquiree (including the acquirer’s consideration transferred and the noncontrolling interest in the acquiree), and the fair value of the net assets (assets - liabilities) of the acquiree.
Under what conditions will a bargain purchase be recognized in a business combination?
A bargain purchase is recognized when the fair value of the total investment in an acquiree (both the investment of the acquirer and that of any noncontrolling interest) is less than the fair value of the acquiree’s net assets.
Under what conditions will Goodwill be recognized in a business combination?
Goodwill is recognized when the fair value of the total investment in an acquiree (both the investment of the acquirer and that of any noncontrolling interest) is greater than the fair value of the acquiree’s net assets.
How should contingent consideration be measured and reported subsequent to a business combination?
Contingent consideration should be measured and reported at fair value until settled. 1. If changes are of fair value as it existed at acquisition date, the change is an adjustment to the cost of the investment; 2. If changes result from events after the acquisition date: (1) Changes in contingent assets or liabilities are recognized in earnings in the period of change; (2) Changes in contingent equity is an adjustment to equity accounts; not an earnings item.
What assets or liabilities recognized in a business combination require “specialized” post-combination accounting treatments?
- Reacquired rights asset; 2. Assets and liabilities arising from contingencies; 3. Indemnification assets; 4. Contingent consideration as asset or liability (or equity).
How should assets and liabilities arising from contingencies be measured and reported subsequent to a business combination?
- If the contingency is a liability, measure and report at the higher of: a. Its acquisition-date fair value; or b. the amount that would be recognized if the requirements of FASB #5 were followed. 2. If the contingency is an asset, measure and report at the lower of: a. Its acquisition-date fair value; or b. The best estimate of its future settlement amount.
What information must be disclosed about Goodwill recognized in a business combination?
- A quantitative description of the factors that make up the Goodwill; 2. The amount of Goodwill expected to be deductible for tax purposes; 3. The amount of Goodwill assigned to each reportable segment; 4. During the measurement period, a reconciliation of the beginning and ending balance in Goodwill.
In which periods does an acquirer have to disclose information about a business combination in its financial statements?
In the reporting period in which the combination occurs and in each reporting period that includes the measurement period.
Identify the most significant general information about a business combination that must be disclosed.
- Name and description of the acquired business; 2. The acquisition date; 3. The percentage voting interest acquired (if relevant); 4. How the acquirer gained control of the acquired business; 5. The primary reason for the business combination.
When provisional amounts for a business combination are reported in financial statements, what must be disclosed about those amounts?
- Identification of the items (assets, liabilities, equity or consideration) for which accounting is not complete; 2. The reasons why the accounting is not finalized; 3. The nature and amounts of any measurement period adjustments made to the provisional amounts during the reporting period.
What method is used by a parent company to carry “investment in subsidiary” on its books?
Cost, Equity or other method.
What is the journal entry by an investor to record an acquisition?
DR: Investment in Subsidiary CR Cash/Other Consideration (Cost)
Where is a Subsidiary reported?
Reported in consolidated statements, unless the parent lacks effective control.
What accounting transaction is required when cost of the Investment is > fair market value of net assets acquired (Acquisition method)?
Recognize (write on) Goodwill.
List the journal entry by the investor to record a merger/consolidation using the acquisition method.
DR: Assets acquired (at FMV) CR: Liabilities assumed (at FMV) CR: Cash/Other Consideration Paid (Cost)
What method is used to record a merger/consolidation?
Acquisition Method.
What accounting transaction is required when cost of the investment is
Recognize gain for bargain purchase amount.
When are consolidated statements required?
Under two major circumstances: 1. When a firm is the primary beneficiary of a variable-interest entity (VIE), the VIE must be consolidated with the primary beneficiary; 2. When a firm has a majority owned (>50% of voting stock) subsidiary, the subsidiary must be consolidated with its parent unless the parent lacks actual effective operating or financial control.
What is the only legal form of business combination requiring consolidated statements?
Business Combination resulting from a legal acquisition.
What is a majority-owned subsidiary that is not consolidated called and how is it accounted for?
A majority-owned subsidiary that is not consolidated is an “unconsolidated subsidiary” and would be accounted for as an investment asset by the parent, using either fair value or the equity method of accounting.
What are the differences between a legal merger or legal consolidation and a legal acquisition that determine whether or not consolidated statements will be required?
In a legal merger or legal consolidation only one entity exists after the combination; therefore, there is no need for a consolidated statement. In a legal acquisition two separate legal entities survive, but under common control. Their financial statements must be consolidated.
Under IFRS, are you required to disclose assumptions related to acquired contingences?
Yes, you are required to disclose these assumptions.
Under IFRS, goodwill is allocated to _________?
Cash generating units.
Contingent assets are recognized in a business combination under U.S. GAAP or IFRS?
These assets are recognized under U.S. GAAP.
What is the requirement and justification for the use of consolidated financial statements?
Consolidated financial statements are required when one entity has effective control of another entity. Because the entities are under common control, GAAP requires that consolidated financial statements be the primary form of financial reporting for the affiliated entities. While in form the entities may be separate legal entities, because of the common control, in substance they are a single economic entity and their financial statements should be presented as a single economic entity.
What are the alternative circumstances that affect adjustments and eliminations made in the consolidating process? (Disregard pooling of interests consideration.)
- Whether the parent carries its investment using the cost or equity method; 2. Whether the consolidation is carried out at the date of the business combination or at a subsequent date; 3. Whether the parent owns 100% (all) of the voting stock of a subsidiary or less than 100% of the stock; 4. Whether transactions between the affiliated companies originate with the parent or subsidiary.
Under U.S. GAAP, what process must be followed to determine if an entity should be consolidated?
First, it must be determined if the entity is a variable-interest entity (VIE). If it is, the reporting entity must determine if it is the primary beneficiary of the VIE and, if so, consolidate the VIE. Then, if the entity is not a VIE, the reporting entity must determine if it has controlling voting interest in the entity. If so, and nothing prevents the exercise of that control, the reporting entity (parent) must consolidate the entity (subsidiary).
List the methods a parent may use to carry investment in subsidiary to be consolidated.
- Cost; 2. Equity; 3. Any other method it chooses.
Identify the general kinds of eliminating entries made in the consolidating process.
- Investment eliminating entry. (Always); 2. Intercompany Receivables/Payables elimination(s); 3. Intercompany Revenues/Expenses elimination(s); 4. Intercompany Profit elimination(s).
What are the kinds of information needed to prepare consolidated financial statements?
- Financial statements/Adjusted trial balances of affiliated entities; 2. Data as of date of acquisition, including: a. Book values of subsidiary’s assets and liabilities; b. Fair values of subsidiary’s assets and liabilities; c. Fair value of noncontrolling interest, if any; d. Fair value of precombination equity interest, if any. 3. Intercompany transaction data and balances.
How does a parent company record a subsidiary?
As an “Investment”.
Define “consolidated financial statements”.
Consolidated financial statements present the financial information of two or more separate legal entities, usually a parent company and one or more of its subsidiaries, as though they were a single economic entity.
What is the basic sequence of steps in the consolidating process?
- Record trial balances on consolidating worksheet; 2. Record adjusting entries, if any; 3. Record eliminating entries; 4. Complete consolidating worksheet; 5. Prepare consolidated financial statements.
Where is the consolidating process carried out?
On a consolidating worksheet; not on the books of any entity.
Where will a noncontrolling interest account show in consolidated financial statements?
On Consolidated Balance Sheet as a separate item within Shareholders’ Equity.
What is the effect on an Investment in Subsidiary account when the parent accounts for its investment using the equity method?
The carrying amount of the investment would change with changes in the equity accounts of the subsidiary, including: 1. Increasing with reported subsidiary profits/decreasing with reported subsidiary losses; 2. Decreasing with the payment of dividends by the subsidiary; 3. Decreasing for “depreciation/amortization” of the excess of fair value over book value at the date of investment.
What steps should be followed to make adjusting entries to help derive the consolidated financial statements?
- Determine if any transactions are in transit between the affiliated entities; 2. Record entry on consolidating worksheet to treat in transit transactions as though they were completed.
What will be the difference(s) in the consolidated statements resulting from the parent using the cost method or the equity method to account for an investment in a subsidiary to be consolidated?
There will be no difference in the final consolidated statements based on which method the parent uses to account for its investment in a subsidiary. The consolidated statements will be the same regardless of which method is used, only the consolidating process will be different.
How is an “in-transit” intercompany transaction handled?
Make an adjusting entry on the consolidating worksheet to complete the transaction as though it had been received by the receiving company.
What is the amount at which any noncontrolling interest is recognized in eliminating entry at the date of business combination?
Fair value of Noncontrolling Interest percentage claim to consolidated net assets attributable to the subsidiary. This would include its claim to the Sub’s net assets at fair value and any Goodwill recognized in the combination.
List some examples of intercompany amounts to be eliminated during a consolidation.
- Receivables/payables; 2. Interest; 3. Dividends; 4. Bonds.
What are the possible accounting methods a parent can use to carry on its books an investment in a subsidiary that will be consolidated?
The parent can use: 1. Cost method; 2. Equity method; 3. Any other method it chooses. Whatever method it uses, the investment account will be eliminated on the consolidating worksheet. (Only the cost and equity methods have been used on prior exams.)
When a parent uses the cost method to carry on its books an investment in a subsidiary that it will consolidate, what entries does the parent make on its books related to the subsidiary?
After recording the investment in the subsidiary on its books, in normal circumstances the parent will only recognize its share of the subsidiary’s dividends declared/paid as dividend income. It will NOT recognize on its books its share of the subsidiary’s reported net income/loss, nor will it adjust its investment account for the subsidiary’s income/loss or dividends.
When a parent uses the cost method to carry on its books an investment in a subsidiary that it will consolidate, what is the purpose of the reciprocity entry made on the consolidating worksheet?
The reciprocity entry adjusts the parent’s investment account for changes in the subsidiary’s retained earnings since the business combination up to the beginning of the period being consolidated that have not been recognized in the parent’s investment account because it is using the cost method of accounting.
What does the investment eliminating entry on the consolidating worksheet accomplish?
It (1) eliminates the investment account (in the subsidiary) brought on to the worksheet by the parent against the shareholders equity accounts (of the subsidiary) brought on to the worksheet by the subsidiary, (2) in the process, it adjusts the subsidiary’s identifiable assets and liabilities to fair value at the date of acquisition, and (3) recognizes Goodwill, if any.
When a parent uses the equity method to carry on its books an investment in a subsidiary that it will consolidate, what entries does the parent make on its books related to the subsidiary?
Adjusts on its books the carrying value of its investment in the subsidiary to reflect: 1. The parent’s share of the subsidiary’s income or loss; 2. The parent’s share of dividends declared by the subsidiary; 3. The amortization/depreciation of the difference between the FMV of identifiable assets (but not Goodwill) and the book value of those assets.
What is the effect on consolidated values when the fair values of a subsidiary’s identifiable assets are less than the subsidiary’s book values for those assets at the date of a business combination?
On the consolidating worksheet: 1. The identifiable assets are written down to fair value at the date of the business combination; 2. Any depreciation/amortization expense on those assets taken by the subsidiary will be reduced on the consolidating worksheet to an amount based on the lower fair values.
How does the noncontrolling interests in a subsidiary’s income/loss and assets/liabilities get reported in consolidated financial statements?
Noncontrolling interest in a subsidiary’s net income or net loss gets reported as a separate line item in the consolidated income statement; the consolidated income/loss is allocated between the parent and the noncontrolling interest. Noncontrolling interest in a subsidiary’s assets and liabilities gets reported as a separate line item in shareholders’ equity in the consolidated balance sheet.
Under what conditions will a bargain purchase gain be recognized by a parent?
When, at acquisition, the fair value of subsidiary’s identifiable net assets is greater than the investment value to acquire those net assets. Investment value is the parent’s investment cost plus the fair value of any noncontrolling interest in the subsidiary.
What amount of intercompany revenues and expenses must be eliminated on the consolidating worksheet?
The full amount (100%) of revenues and expenses that resulted from intercompany transactions must be eliminated, even if the transaction did not result in a profit to the “selling” affiliate.
What amount of intercompany receivables and payables must be eliminated on the consolidating worksheet?
The full amount (100%) of receivables and payables that resulted from intercompany transactions must be eliminated on the consolidating worksheet.
What are the only types of transactions recognized for consolidation?
Transactions with non-affiliates.
List the main types of intercompany transactions and intercompany balances.
- Receivables/payables; 2. Revenues/expenses; 3. Inventory; 4. Fixed assets; 5. Bonds.
What is the treatment of intercompany transactions and balances on the consolidating worksheet?
Eliminate all Intercompany transactions and balances.
What are the accounts (on a consolidating worksheet) that may be affected by an intercompany inventory transaction?
- Sales/Purchases; 2. Net income/loss; 3. Ending Inventory; 4. Beginning Inventory.
What is the entry on the consolidating worksheet to eliminate intercompany inventory profit that is in ending inventory?
DR: COGS (or Inventory) - I/S CR: Ending inventory - B/S The entry eliminates the profit brought on the worksheet by the selling affiliate and reduces the ending inventory brought on the worksheet by the buying affiliate to cost from an outsider.
What is the entry to eliminate intercompany inventory sales and intercompany inventory purchases on the consolidating worksheet?
DR Intercompany Sales CR: Purchase (Inventory) The entry would be for the full amount of intercompany sales/purchases during the period.
What is an intercompany inventory transaction?
When one affiliated entity sells goods to be resold (merchandise inventory) or used (raw materials inventory) by the buying affiliate an intercompany inventory transaction has occurred.
Since intercompany inventory sales and intercompany inventory purchases exactly offset each other, resulting in no net effect on consolidated income, why must they be eliminated?
Intercompany inventory sales and intercompany inventory purchases must be eliminated so that the absolute amount of sales and purchases will not be overstated on the consolidated income statement. Such overstatements would misrepresent the level of operating activity for the firms.
What are the differences between when a 100%-owned subsidiary sells goods for a profit to a parent and when a less-than-100%-owned subsidiary sells goods for a profit to a parent?
In both cases, the full amounts of the intercompany sales and purchases have to be reversed and the full amount of profit in ending inventory has to be eliminated (by reducing profit and reducing inventory carrying value). When the subsidiary is 100% owned, the parent (and parent shareholders) absorb the entire effect of the reductions. When the subsidiary is less than 100% owned, the reductions (in profit and asset value) are allocated between the parent and the noncontrolling interest based on percentage ownership.
What amount of intercompany inventory sales and intercompany inventory purchases must be eliminated?
The full amount (100%) of intercompany inventory sales and intercompany inventory purchases must be eliminated (against each other) on the consolidating worksheet, even if the sale was at no profit to the selling affiliate.
If not eliminated, what effect will the intercompany sale of a fixed asset at a loss have on the reported value of the fixed asset for consolidated statement purposes?
Unless the appropriate eliminating entry is made, the intercompany sale of a fixed asset at a loss will result in an understatement of the value of the fixed asset on consolidated financial statements.
How is a gain or loss on an intercompany sale of a fixed asset confirmed (recognized) for consolidated statement purposes?
A gain or loss on an intercompany sale of a fixed asset is confirmed through the depreciation expense taken each period by the buying affiliate on the intercompany profit or loss. When the sale was at a gain (loss), the buying affiliate will take more (less) depreciation than the selling affiliate would have taken. That difference (each period) confirms a part of the gain or loss each period.
What is the eliminating entry for consolidating purposes that would be necessary immediately following an intercompany sale of a fixed asset at a gain?
DR: Fixed Asset to reestablish original cost from non-affiliate. DR: Gain to eliminate intercompany gain on sale. CR: Accumulated Depreciation to reestablish accumulated depreciation written off by selling affiliate.
List the consolidation accounts affected by intercompany fixed asset transactions.
- Net Income; 2. Fixed Asset; 3. Accumulated Depreciation; 4. Depreciation Expense/Accumulated Depreciation.
If not eliminated, what effect will the intercompany sale of a fixed asset at a gain have on the reported value of the fixed asset for consolidated statement purposes?
Unless the appropriate eliminating entry is made, the intercompany sale of a fixed asset at a gain will result in an overstatement of the value of the fixed asset on consolidated financial statements.
What effect does an intercompany sale of a fixed asset by a less than 100% owned subsidiary to a parent have on the consolidated financial statements that is different than the sale by a parent to a subsidiary or by a 100% owned subsidiary to a parent?
In all cases the full amount of any intercompany gain or loss will be eliminated; however, if the sale is from a less-than-100%-owned subsidiary, the gain or loss (and subsequent elimination adjustments of depreciation expense) will be allocated on the worksheet between the parent and the noncontrolling interest in proportion to their ownership percentages.
When do intercompany bonds exist?
When one affiliate owns (as an investment) the bonds issued by another affiliate (a liability).
What determines the amount of any net gain or loss resulting from bonds becoming intercompany?
The sum or difference between the premium or discount on the bond investment (of the buying affiliate) and the premium or discount on the bonds payable (of the issuing affiliate). Gain would result from eliminating: 1. Premium on Bond Payable or 2. Discount on Investment. Loss would result from eliminating: 1. Discount on Bond Payable or 2. Premium on Investment.
How does the gain or loss on constructive retirement of intercompany bonds get recognized on the books of the separate affiliated companies?
The gain or loss on constructive retirement of intercompany bonds get recognized on the books of the separate affiliated companies through the amortization on their separate books of the premium(s) and/or discount(s) on the bond investment and/or the bonds payable.
For consolidated purposes, what accounts can be affected by intercompany bonds?
- Bonds Payable; 2. Premium or Discount on Bonds Payable; 3. Investment in Bonds; 4. Premium or Discount on Investment in Bonds; 5. Interest Income/Interest Expense; 6. Interest Payable/Interest Receivable.
What eliminating entry would be required for consolidating purposes immediately following an intercompany bond purchase that involved a discount on bonds payable and a premium on bond investment?
DR: Bonds Payableat face amount Loss on Constructive Retirement - sum of Premium on B/I + Discount on B/P CR: Investment in I/C Bonds at face amount CR: Premium on I/C Bond Investment - for full amount CR: Discount on I/C Bonds Payable - for I/C amount.
What are two objective differences between U.S. Generally Accepted Account Principles (GAAP) and International Financial Reporting Standards (IFRS) in determining control?
Under U.S. GAAP only outstanding voting rights are used to measure control; under IFRS securities currently exercisable or convertible into voting rights are used in assessing control. Under U.S. GAAP only if an entity has more than 50% voting ownership can it have control. Under IFRS an entity may have control even when it does not have more than 50% voting control.
What is the main difference in the preparation of financial statements between consolidating financial statements and combining financial statements?
In consolidating financial statements, the investment accounts of the parent company in the other companies being consolidated are eliminated against the parent’s percentage ownership of the equity of those companies. In combining financial statements, any investment one combining company has in another combining company is eliminated against the owned company’s equity in the amount of the investment, not in the amount of percentage ownership. Therefore, there can be no difference between the dollar amount of the investment and the dollar amount of equity eliminated.
What is the main different between when combined financial statements would be appropriate and when consolidated financial statements would be appropriate?
Consolidated financial statements must be prepared only when one of the companies being consolidated (a parent company) has controlling interest, either directly or indirectly, in the other companies being consolidated. Combined financial statements can be prepared when there is no single company (parent company) that has control of the companies being combined.
Identify at least five financial liabilities.
- Accounts payable; 2. Notes and Bonds payable; 3. Option contracts (with unfavorable terms); 4. Futures and forward contracts (with unfavorable terms); 5. Swap contracts (with unfavorable terms).
What are the basic types or categories of financial instruments?
- Cash; 2. Evidence of an ownership interest in an entity; 3. Contracts that result in an exchange of cash or ownership interest in and entity that: a. Imposes on one entity a contractual obligation (liability); and b. Conveys to a second entity a contractual right (asset).
Identify at least five financial assets.
- Cash and cash equivalents; 2. Accounts receivable; 3. Investments in debt or equity securities; 4. Ownership interest in a partnership, joint venture, or other entity; 5. Option contracts (with favorable terms); 6. Futures and forward contracts (with favorable terms); 7. Swap contracts (with favorable terms).
What are the categories of financial liabilities identified under International Financial Reporting Standards (IFRS)?
- Financial liabilities measured at fair value with changes reported through profit/loss, including: a. Liabilities held for trading; b. Derivatives (that are liabilities); c. Financial liabilities for which the fair value option is elected. 2. Other liabilities.
What are the categories of financial assets identified under International Financial Reporting Standards (IFRS)?
- Financial assets measured at fair value with changes reported through profit/loss; 2. Loans and receivables; 3. Instruments held to maturity (other than loans and receivables); 4. Instruments available for sale.
How are financial assets that are classified as “Loans and Receivables” measured and reported under International Financial Reporting Standards (IFRS)?
Financial assets classified as “Loans and Receivables” under IFRS are measured at amortized cost, with related interest and amortization recognized in current income.
Under International Financial Reporting Standards (IFRS), how is an impairment of a financial asset determined and reported?
Under IFRS, an impairment loss is determined as the difference between the carrying amount of the asset and its recoverable amount. The amount of any impairment loss is recognized in current income.
What must be disclosed about each significant concentration of credit risk?
- Information about the common activity, region, or economic characteristic that identifies the concentration; 2. The maximum (gross) amount of loss due to the credit risk; 3. The entity’s policy of requiring collateral or other security to support financial instruments subject to credit risk; 4. The entity’s policy of entering into master netting arrangements to reduce the credit risk associated with financial instruments.
If it is not practicable to estimate the fair value of a financial instrument, what must be disclosed?
- The reasons why it is not practicable to estimate fair value and 2. Information pertinent to estimating fair value, such as carrying amount, effective interest rate, maturity date, etc.
Define “market risk”
Market risk is the possibility of loss from changes in market values due to changes in economic circumstances, not necessarily due to the failure of another party to perform.
Define “credit risk”.
Credit risk is the possibility of loss from the failure of another party (or parties) to perform according to the terms of a contract.
List the disclosure requirements for financial instruments where it is practicable to estimate fair value.
- Fair Value; 2. Related carrying amount; 3. Whether instrument/amount is an asset or liability.
What is the “underlying” element of a derivative instrument?
A specified price, rate, or other variable (e.g., a stock price, interest rate, currency exchange rate, etc.).
Define “hedging”.
A risk management strategy that involves using offsetting (or counter) transactions or positions.
What are the three basic elements of a derivative?
- One or more underlying and one or more notional amounts; 2. Requires no initial net investment; 3. Terms require or permit a net settlement.
What is an embedded derivative?
An embedded derivative is a portion of, or term in, a contract (host contract that is not itself a derivative) that behaves like a derivative.
What is the “notional” amount element of a derivative instrument?
A specified unit of measure (e.g., number of shares of stock, pounds or bushels of a commodity, number of foreign currency units, etc.).
How is the value or settlement amount of a derivative determined?
By the multiplication (or other calculation) of the notional amount and the underlying.
List the four different possible uses of derivatives.
- Derivatives not used as a hedge; 2. Fair value hedges; 3. Cash flow hedges; 4. Foreign currency hedges.
What is the formal documentation required at the inception of a fair value hedge?
- The hedging relationship; 2. The objective and strategy for undertaking the hedge; 3. Identification of the hedging instrument; 4. Nature of the risk being hedged; 5. How effectiveness of the hedge will be assessed.
Define a “fair value hedge.”
The hedge of exposure to changes in fair value of a recognized asset, recognized liability, or an unrecognized firm commitment from a particular risk.
List the conditions under which an “unrecognized firm commitment” exists.
When an entity enters into a contract to buy or sell but has not yet booked the transaction.
What are the accounting requirements for a change in the fair value of a fair value hedging instrument and the asset, liability, or firm commitment being hedged?
- Adjusting carrying amount of the derivative and hedged item to fair value; 2. Recognizing gains/losses from revaluing the derivative and the hedged item in current income.
Define a “cash flow hedge”.
The hedge of an exposure to variability (changes) in the cash flow associated with a (recognized) asset, liability, or a forecasted transaction due to a particular risk.
Define a “forecasted transaction”.
A forecasted transaction is a planned or expected transaction for which there is not yet either a firm commitment or any rights or obligations established.
What are the conditions necessary for a forecasted transaction to be the hedged item in a cash flow hedge?
The forecasted transaction is: 1. Specifically identified as a single transaction or group of individual transactions with the same risk exposure; 2. Probable of occurring; 3. With an external party (with limited exceptions); 4. Capable of affecting cash flows and earnings; 5. Not for acquisition of an asset or incurrence of a liability accounted for at fair value with the change reported in current income.
How are changes in the fair value of derivatives used to hedge cash flows treated?
Each period the change in fair value of the derivatives is used to: 1. Adjust the derivative instrument to fair value; 2. Recognize in other comprehensive income an amount equal to the change in present value of expected cash flows of the hedged item; 3. Recognize any difference between change in fair value and change in present value of expected cash flows in current income.
Identify five (5) kinds of foreign currency exposure that may be hedged.
- Forecasted foreign-currency-denominated transactions; 2. Unrecognized foreign-currency-denominated firm commitments; 3. Foreign-currency-denominated recognized assets or liabilities; 4. Investments in AFS Securities; 5. Net investments in foreign operations.
Define “foreign currency hedge”.
The hedge of an exposure to changes in the dollar value of assets or liabilities (including certain investments) and planned transactions that are denominated (to be settled) in a foreign currency.
What should disclosures for derivatives designated as fair value hedges distinguish between?
Fair value hedges, cash flow hedges, hedges of investments in foreign operations, and other derivatives.
List the required disclosures for derivatives designated as fair value hedges.
- Net gain/loss recognized in earnings and where net gain/loss is reported in the financial statements; 2. Net gain/loss recognized in earnings from hedged firm commitments that no longer qualify for hedge treatment.
Are part term hedges allowed under IFRS?
Part term hedges are allowed.
Which U.S. GAAP characteristic of a derivative is not included in the definition of a derivative under IFRS?
Notional Amount.
What is the control determination concept?
The determination of whether or not a party transferring a financial asset has surrendered control over the asset.
What are the basic criteria for transfer of control over a financial asset?
- The transferred asset has been isolated from the transferor and its creditors; 2. Each transferee has the right to pledge or exchange the asset received; 3. The transferor does not maintain effective control over the transferred assets.
What are the three basic concepts that underlie accounting for transfers of assets and servicing of assets?
- Control determination concept; 2. Financial-components concept; 3. Participating interest concept.
What is a participating interest?
It is a relationship between one entity (commonly the transferor) with an interest in an entire financial asset and other entities that have an ownership interest in that financial asset. For the relationship to be a participating interest, the interest of all parties must be in an entire financial asset and those interests must have the same priorities and be proportional to ownership with respect to cash flows. Further, the pledging or exchanging of the asset can occur only if all parties agree.
Define the “financial-components concept”.
Financial assets and liabilities can be disaggregated into components becoming separate assets/liabilities.
Under what conditions will a transferor write off (and a transferee recognize) a non-cash financial asset transferred as collateral in a secured borrowing?
When the transferor has defaulted under the terms of the contract and is no longer entitled to redeem the pledged asset. In that case, the transferor will write off the financial asset and the transferee will recognize the financial asset (collateral).
What are the requirements for accounting for the transfer of a financial asset as a sale by the transferor?
- Write off asset sold (or portion thereof); 2. Write on assets obtained and liabilities incurred; 3. Measuring assets and liabilities at fair value; 4. Recognizing gain/loss on the sale in current earnings.
Under what conditions is the transfer of a financial asset treated as a secured borrowing with the pledge of collateral?
The transfer of a financial asset is treated as a secured borrowing with pledge of collateral when either: 1. The criteria for surrender of control are not met; or 2. A portion (component) of a financial asset that is not a participating interest is transferred.
Describe the accounting treatment for a transfer of a financial asset if criteria for surrender of control are met.
The criteria for surrender of control must be met and either: 1. An entire asset transferred; or 2. A component of an asset that qualifies as a participating interest is transferred.
If a portion of a financial asset is sold and another portion retained, how is the amount to be initially recognized for each portion determined?
The carrying value of the entire asset (pre-transfer) is allocated between the portion sold and the portion retained based on their relative fair values at the date of transfer.
List the accounting requirements for the purchase of financial assets by the transferee.
- Writing on all assets obtained and liabilities incurred; 2. Measuring all assets and liabilities at fair value.
What does the appropriate accounting for the transfer of a non-cash financial asset as collateral in a secured borrowing depend on?
- Whether secured party has the right to sell or repledge the collateral; 2. Whether debtor has defaulted.
For transfers of financial assets that are appropriately either a sale or secured borrowing with pledge of security, what are the basic guidelines for accounting treatment?
Basic accounting guidelines: 1. Derecognize a transferred asset or portion thereof that qualifies as a sale; 2. Continue to recognize a transferred asset or portion thereof (i.e., a retained interest) that does not qualify as a sale; 3. Recognize any assets or liabilities that result from the transfer.
How is the gain or loss on the transfer of a financial asset (or portion thereof) treated as a sale determined?
The gain or loss is measured as the difference between the proceeds received from the sale and the carrying value of the asset (or portion thereof) sold. Proceeds of the sale include any assets obtained and (less) any liabilities incurred in the transfer.
What condition results in a servicing liability?
Estimated future revenues are expected to be less than estimated costs of servicing the assets, as reflected in fair value.
At what amount are separate servicing assets and servicing liabilities initially recognized?
At fair value at the date of separation from a transferred financial asset or at date of acquisition.
What methods may a holder use to measure a servicing asset or a servicing liability after initial recognition?
Subsequent to initial recognition, a servicing asset or servicing liability may be measured at either: 1. Amortized in proportion to and over the period of estimated net income or net loss; or 2. At fair value, with changes in fair value recognized in current income. In either case, a servicing asset should continue to be assessed for impairment.
What condition results in a servicing asset?
Estimated future revenues are expected to exceed estimated costs of servicing the assets, as reflected in fair value.
What are some common terms used in Transfers of Financial Assets?
Common Terms include: 1. Interest only strip 2. Cleanup call 3. Securitization 4. Wash Sales 5. Factoring
What are some major disclosure requirements for a transferor that transfers financial assets in a securitization treated as a sale?
For securitized financial assets accounted for as a sale, disclose information for each major type about: 1. Accounting policies; 2. Characteristics of the securitizations and gain/loss on assets securitized; 3. Key assumption used in measuring fair value at securitization and sensitivity of those measures to changes in key assumptions.
What are some major disclosure requirements for a transferee in a secured borrowing with pledge of collateral?
- Policy for requiring collateral; 2. For collateral that it is permitted to sell or replete: a. Information about sources and uses of collateral; b. Fair value; c. Portion of such collateral that has been sold or repledged.
Under what conditions will a debtor write-off (derecognize) a liability?
The debtor pays the creditor and is relieved of its obligation for the liability. OR The debtor is legally released from being the primary obligator under the liability either by the creditor or by law/courts.
If a debtor is released as being primarily responsible for a liability but becomes secondarily responsible for the liability, what should be its accounting related to that change?
It will: 1. Derecognize the original liability and the consideration paid for release; 2. Recognize at fair value any liability associated with being secondarily liable for the obligation; 3. Recognize a gain or loss as the difference between the original liability written off and the consideration paid plus the fair value of the secondary liability.
